Tag Archives: financial security

Financial fitness from the viewpoint of personal fitness

Posted on February 1, 2013 | Leave a comment

This post was provoked by a comment I read in a financial industry publication from Stuart Ritter of T. Rowe Price’s retirement services division.

Ritter said “saving 3% for retirement is like going to the gym for six minutes.” Acknowledging low rates of savings for many retirement plan participants, Ritter’s contention is that just as 30 minutes of exercise should be a minimum daily routine, savings for retirement should also be done at five times his example. Instead of saving 3% of annual salary, most people should save 15%.

I think Ritter’s quote goes a bit too far. There are some people who couldn’t manage a decent quality of life (even without living beyond their means) if they deferred 15% of their income into retirement savings. An important thing to consider when determining how much to save for retirement is how much of the heavy lifting you want to rely on investment markets to do and how much of it can you do by managing a prudent financial life that pays yourself first via retirement savings.

If you are saving just 3% of annual income, investment markets will be forced to do much more of the heavy lifting to get you to a point where you can come reasonably close to replacing your earned income in retirement by combining Social Security and withdrawals from investment accounts.

For the dwindling few (mostly government employees) who will receive an employer-funded stream of pension income in retirement, saving just 3% of income in addition to the pension may actually be adequate for living lean in retirement. For the majority, it won’t – especially if the savings is not invested in aggressively enough over the long-term to generate a meaningful rate of return.

Consider if at age 30 – possibly after paying off student loans and saving for a down payment on a home, a couple (or even a single wage earner) make $80,000 per year and their income grows at 2.5% per year. If they saved 3% of income in a pre-tax employer retirement plan and earned a 7% average annual investment return for 35 years, retiring at 65, they would have $473,846 of savings. This balance, assuming it continued to earn 7% returns for 30 years of retirement could reasonably be expected to generate approximately $1,400 per month of inflation-adjusted after-tax income to age 95. Add that to the average Social Security benefit and the couple (or individual) has to learn to live on a lot less than while they were working.

I think a more prudent minimum retirement savings is 10% of annual income. Apply the same scenario as before with 10% savings (perhaps through both personal and employer match contributions) and the balance after 35 years is $1,457,633 pre-tax. It would have about a 70% probability of supporting  $4,400 per month of after-tax spending for 30 years to age 95.

Of course, many people can’t afford to save 10% of their annual income early in their career but they expect to increase their contributions over time. What if someone upped their retirement plan contribution by 1% every two years. They start at 3% for two years, then 4% for two years and so on until they reach 15% of their income for the final 10 years of their career. Would they ever catch up to the person who saved 10% throughout? No. Even though they would have contributed approximately $58,000 more dollars to the retirement plan, saving much more during the peak earnings years, they would end up a bit less than $200,000 behind the consistent 10% saver. This is due to the missed opportunity to have more money growing and compounding returns in the early years.

While saving just 3% of income for retirement won’t sustain the same standard of living as pre-retirement, saving 15% throughout a career could be oversaving for some people, sacrificing a little bit too much today for the opportunity to use it in retirement.

The most important point is to take the time (or hire an independent financial advisor) to determine what amount of savings you will likely need to live on in retirement. This will inform your level of needed savings throughout the remainder of your working life and also be a guide for the appropriate investment strategy.

  • What can you do to increase your rate of savings in retirement plans?
  • Do you know how much money you need to save today to replace your income in retirement?

~ Gary Brooks, CFP® – Brooks, Hughes & Jones – Partners in Wealth Management – Tacoma, WA

www.BHJadvisors.com

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Long-term care insurance cost may actually stop rising

Posted on November 2, 2012 | Leave a comment

Nearly 10,000 Baby Boomers retire each day and one of their prominent decisions about financial security is how can they protect against the risk of needing expensive long-term health care. The long-term care (LTC) insurance industry is changing so rapidly that people considering policies this year have different considerations about premiums and coverage than people who purchased policies last year.

Over the past few years, the LTC marketplace has had to withstand a series of challenges. The underwriters for the major LTC providers made some large miscalculations when they originally priced their policies.

  • They counted on the fact that at least 5% of LTC policy holders would decide not to continue to pay the premium and would let their policies lapse. In most cases these lapse rates have been closer to 1% than to 5%.
  • They assumed that the interest rates paid on bonds would be considerably higher than they presently are. It is very difficult for an LTC insurance carrier to provide a guaranteed 5% compound rate of inflation for a LTC insurance policy holder when they can’t earn that return in the bond markets.
  • They also assumed that a lower percentage of people who actually bought LTC insurance would need to use their policy to make claims.

These incorrect assumptions have led to some bad outcomes:

  • Prudential Insurance Company quit writing new LTC policies in March of this year. It joined Metropolitan Life, TIAA-CREF and Unum in exiting this business line.
  • Rates have risen for existing policy holders at levels that most LTC buyers never thought possible. John Hancock raised rates for one group of its LTC policy holders in Illinois by 90%!

Even with these huge increases, the costs for keeping existing LTC policies are LESS than the cost for ending the policy and buying a new one based on your current age.

In a recent post, financial planner and blogger Michael Kitces reviewed these changes as well as the outlook for the LTC market. His conclusion is that the days of these huge increases in annual LTC premiums are numbered because the underwriters for the LTC insurance providers who are still around have planned for the worst when they have re-priced their policies. This has made the current pricing for these policies “more appropriate” according to Kitces. He also suggests that policies that are issued today will have a history of rate increases that “is likely to be less severe” than policies issued in the past.

If this is true, then maybe the surprises for all concerned, the LTC carriers, current policy holders, and new LTC policy buyers will be reduced. This will be a situation that is good for all.

What is your position on long-term care insurance vs. self insuring the risk?

How much has your LTC insurance premium risen over time?

~ Allyn Hughes, CFP®, ChFC®, CLU® — Brooks, Hughes & Jones — Partners in Wealth Management – Tacoma, WA

www.BHJadvisors.com

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Can you afford to self insure against the risk of needing long-term care?

Posted on August 21, 2012 | Leave a comment

For many people, their financial security in retirement could hinge on a potentially expensive need for long-term care.

The decision of whether or not to protect against this risk through the purchase of long-term care insurance is a very important consideration for most people in their late 50s and early 60s.

Some affluent people can clearly self insure this risk, setting aside savings or investments to cover potential future costs. But there are many people who are squarely in between a clear ability to self-insure and a clear need to purchase insurance.

If you are deciding whether or not you can afford to self insure against the potential need for long-term care, there is a calculator that does a nice job of estimating the potential expense that you could face and how much you would need to save to overcome that expense.

The calculator available here starts with default entry points but you can change them to reflect your situation and other assumptions.

For instance, you’ll see a default annual cost of long-term care of $50,000. This figure may be applicable to in-home care and assisted living but more comprehensive nursing home care costs $80,000+ on average in Washington state. Another variable to change is inflation of long-term care costs. General cost of living may rise about 3% per year but health care costs increase faster. It’s better to enter 5% inflation if you are below age 70. If you are much above age 75, then a 3% inflation level should suffice. The length of long-term care need is a significant wild card in this equation. The average nursing home stay is 2.4 years and the average person entering a nursing home is 79 years old. Of course, you probably have a relative or acquaintance who spent many more years in a facility, particularly if memory care was needed.

Given a certain set of assumptions, let’s look at how much you would need to save to self insure a future need for long-term care.

This scenario produced the following outcome:

“Your future long-term care needs total $324,139. You have available assets of $10,000. To self-insure you will need to save $10,505 per year increasing at 0.0%, or, you can set aside a lump sum of $122,356 today and let it accumulate interest until needed. Alternatively, you could consider purchasing a long-term care insurance policy to cover the potential future expenses.”

You’ll notice that because of the annual inflation of LTC expenses, today’s $75,000 per year becomes $158,503 in 18 years when the hypothetical LTC event occurs.

Of course, you can change the variables to do some “what if?” calculations of your own.

The alternative to saving $10,505 per year in this instance would be to purchase long-term care insurance with enough benefit to cover much of the potential costs. The long-term care premium would be less than the $10,505 per year in invested savings. Premium rates differ based on age at the date of application, overall health and the amount of coverage purchased. In general, a relatively healthy couple in their early 60s could obtain three years of coverage at $150 per day with 3% compound inflation, 90-day elimination period for around $3,500 per year. Premiums are generally less expensive the earlier you apply if you are healthy. There are many ailments and conditions that can show up between 55 and 65 that cause the cost of policies to climb the longer you wait.

The premium would rise over time at different rates depending on the claims history of all of the people who purchased the same policy.

If you never qualify for long-term care or have only a brief need, your premiums would not be recovered. Alternatively, your own savings intended to self insure would be available to you for other goals or to bequest to your heirs.

In many cases, when long-term care is needed – particularly expensive nursing home care or full-time care in your own home – the cost of the LTC insurance could be more than offset by the benefits paid out in less than two years.

It’s an important consideration. Even if self insurance is the answer, that conclusion should only be reached after thorough review of the pros and cons in the context of your overall financial plan.

For more information about recent changes and challenges of the long-term care insurance industry, please read this article I wrote in the Tacoma News Tribune August 1.

To do:

  • Use the calculator to determine what you may need to save in order to be able to self insure your long-term care needs.
  • Determine if you are healthy enough to qualify for a long-term care policy.  Most LTC insurance carriers will not accept people who have heart issues, diabetes cancers or other conditions that would make them more likely to become disabled.
  • If you are healthy enough, then contact your financial professional to get a quote for this insurance.

~ Gary Brooks, CFP® — Brooks, Hughes & Jones, Partners in Wealth Management, Tacoma, WA

www.BHJadvisors.com

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Long-term care costs … still expensive, but growing slower in some cases

Posted on April 20, 2012 | Leave a comment

The cost of long-term health care services has historically advanced at a fast pace. When we consider long-term care costs and insurance policies in our comprehensive financial plans, we assume those costs will double general inflation and grow approximately 6% per year.

According to Genworth’s 2012 Cost of Care Survey, long-term care expenses have moderated a bit for in-home care and nursing home care. These costs have lessened moreso nationwide than in Washington state, however.

Some interesting numbers courtesy of the Genworth study, as relayed by the South Sound Business Examiner:

  • Most people prefer in-home care whenever possible. The cost of in-home health aide services in Washington has risen only slightly over the past five years. As the need for these services has grown, competition to provide service has increased keeping prices in check.
  • Nationally, the median hourly cost for home health aide services is $19. In Washington it is $22 per hour. The cost reflects an increase of less than 1% over the past five years.
  • The median annual cost for care in an assisted living facility is $39,600 nationally. The comparable cost in Washington is $51,000. The national yearly cost for assisted living has increased 5.7% a year over the past five years, while long-term care costs in Washington have increased 7.2% a year during the same time period.
  • Nationally, the median annual cost for a private nursing home room rose 4.3% annually over the past five years to $81,030, while costs in Washington increased 4.6% a year during the comparable time period to $96,842.

While competition has grown due to demand for these services, insuring against the risk of long-term care expenses has gotten a little less competitive. Two years ago, MetLife exited the LTC insurance business. This year, Prudential followed. Because more claims have been filed on LTC insurance policies, the business is less profitable than some insurers would like it to be. Others that have not left the business have revised their pricing significantly.

It’s important to think about the critical role that health care expenses play in your overall financial security. In many cases, protecting against the risk of large expenses is a wise move. Long-term care insurance policies can be designed with many different variables that impact the price and the coverage. It’s important to design coverage that fits with your overall financial plan.

~ Brooks, Hughes & Jones, Partners in Wealth Management, Tacoma, WA

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Challenges facing bond investors, reasons to hold them

Posted on March 31, 2011 | Leave a comment

The following chart from Natixis Investments demonstrates how interest rates impact bond markets, particularly long-term government bonds. Over the past 30 years, generally declining interest rates have fueled bond returns that have easily outpaced inflation (6% real return). But go back to the previous 30 years when rates had a long upward trend and you can see that U.S. long government bonds lost ground to inflation (-1% real return).

Many economy and market watchers forecast that we are entering a period in this cycle similar to the green portion of the graph above with interest rates generally climbing for an extended period. This will make it harder to build financial security with a bond-heavy investment mix.

Couple this with recent comments from Ben Inker, head of asset allocation at money manager Grantham, Mayo, van Otterloo (GMO). Government bond yields are now at 60-year lows, Inker said at a presentation March 25. The last time bond yields were this low was the 1940s and they generated returns worse than cash for 40 years.

This doesn’t mean investors should avoid bonds entirely. U.S. Treasury bonds may not be attractive but a well diversified bond portfolio can still add value to an investment mix by holding corporate bonds, foreign bonds (where government finances are in better shape than the U.S.), and specialty bonds like floating rate bank loans.

This type of mix may not outpace inflation significantly, the way bonds have for the past several years, but it can be expected to provide a welcome buffer for periods when the stock market is not in favor. The magnitude of losses for bonds compared to stocks is minimal even when it is not an opportune time to build wealth through bond investments.

According to Fidelity Investments, in the period from 1941-81 when bonds struggled, the probablity of suffering a negative return in Treasury bonds in any one-year period was just 10.3%. The probability of negative Treasury bond returns over a three-year period was just 0.8%.

~ Brooks, Hughes & Jones, Partners in Wealth Management, Tacoma, WA

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Deciding When to Start Social Security

Posted on June 2, 2010 | Leave a comment

The decision about when to start receiving Social Security benefits is, for many people, the single biggest factor in determining financial security in retirement.

Alicia Munnell and her team at the Center for Retirement Research at Boston College have produced a document that does a nice job of outlining the benefits and consequences of starting Social Security at 62 vs. waiting for full retirement age or even age 70 to maximize retirement income.

Social Security Claiming Guide (PDF) This link takes you to an interactive PDF file. It’s a large file. It will take several seconds to load. Where you see magnifying glasses on each page, hover over the icon with your cursor to zoom in on more details.

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Managing Risk; The Most Important Part of the Plan

Posted on June 2, 2010 | Leave a comment

Each of us thinks about the risks that we take in our own way. Some people have no difficulty taking risk in their personal lives but are more risk averse in their financial decisions. Others are just the opposite.

We focus our efforts on helping our clients’ better understand the balance between financial risk and their progress toward life goals.  We think about financial risks from two perspectives:

  1. Minimizing threats to financial security by using a prudent amount of insurance to protect against untimely death, disability or long-term care requirements.
  2. Understanding the amount of investment risk that each client is comfortable taking to achieve a financial goal.

Thinking about risk in both of these ways helps us make recommendations that may increase the likelihood that our clients will achieve their goals.

Insuring against risks is usually clear and less complicated. Defining and responding to investment risks is a different story.

Some clients have sufficient assets and guaranteed income streams (pension, Social Security, property income) to have a nearly bulletproof retirement plan, given their lifestyle preferences. They aren’t reliant on growth of their assets to meet their goals so they choose a conservative investment approach.

Others in the same situation, particularly entrepreneurial folks accustomed to taking risk, prefer to strive for growth beyond their basic income and asset needs. They have a “go for it” mentality to increase their personal wealth.

Then there are folks who have lifestyle ambitions or early retirement visions that aren’t as adequately funded. They may perceive little choice but to have investment returns do the heavy lifting required to meet their outsized goals.

Often, this leads to a misinterpretation of investing vs. speculating. As financial advisors, we think that investing should be done with an expectation of a margin of safety around the expected outcome over a full market cycle. This margin is thin or non-existent if you are speculating.

Speculating may be lucrative. In fact, the greatest fortunes in the world have come from speculating or concentrating investment in a single idea. But speculating comes with potential consequences that can be disastrous, especially if you don’t have a significant time horizon to make up for the setback.

In a rational investment world, you can differentiate between investing and speculating. But clearly, global markets don’t always act rationally and even “good” investments over the past decade have delivered returns that exposed downside risk and appeared more speculative.

As psychologist Paul Slovic is quoted in The Intelligent Investor, Benjamin Graham’s classic book on investing: “risk is brewed from an equal does of two ingredients—probabilities and consequences.”  As advisors, it’s important to us to be realistic about our probability of being right and understand how clients could react to the consequences of markets not behaving as expected.

The difficulty in predicting responses to market fluctuation lies in the tough-to-judge emotional responses tied to money. We find that one way to understand the impact of risk and therefore better predict how people will actually respond to market downturns is to measure their loss cushion. How much could they see their assets decline and still be able to support goals, such as a 30-year stream of retirement income, at an acceptable level.

People with relatively little loss cushion need to be far more aware of the risk in their portfolio.  This is a fundamental tenant of our financial planning philosophy.

Regardless of our clients’ mentality, it is our role as a Registered Investment Adviser firm, and as Certified Financial Planners, to act as fiduciaries in the clients’ best interest.

As fiduciary advisors, we are careful to manage investments prudently. We ask ourselves:

  • Are there unintended risks/consequences in a portfolio—like having too many bonds of one type or too much exposure to any specific country, currency or industry?
  • Are our expected returns too low or high?

When evaluating expected returns, we feel it’s important to:

  • look beyond long-term averages which create an inaccurate sense of security
  • consider fluctuation in historical returns and sequence of those returns, to understand realistic moves from year to year, their depths and their heights
  • evaluate attractiveness of investments by fundamental measures, regardless of the present direction of markets

With the answers to those questions, we work to create investment portfolios for our clients that help them manage both their risk levels and return expectations. We focus on:

  • Understanding their short- and long-term goals
  • Being sensitive to their tolerance for market fluctuation (risk!)
  • Knowing  the likely holding period of the portfolio
  • Working to manage both the expenses and tax implications of the investment portfolio
  • Diversifying holdings to mitigate some risk

We understand that from time to time, our assumptions and the probabilities we assign to expected outcomes will be wrong. But as long as we are generally correct in our direction and not precisely wrong with speculation, we will help our clients achieve financial security.

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Protect Your Greatest Asset—Your Income

Posted on May 16, 2010 | Leave a comment

May is National Disability Insurance Awareness Month. Myths and assumptions about the need, or lack thereof, for disability insurance make it critical that more awareness is developed to understand the potential risk of losing your income.

Your ability to earn income—your human capital—is a far bigger influence on financial security than any other asset you have. Income makes everything in your financial plan possible. Your home, car, education savings, retirement savings and all the other costs that make up your lifestyle and your expectations, are susceptible to a loss of income.

Consider this example of your earnings potential between now and age 65, assuming a 3% annual cost of living raise:

Annual income $50,000 $100,000 $150,000
Currently 30 years old $3,163,797 $6,327,594 $9,491,391
40 years old $1,927,652 $3,855,304 $5,782,956
50 years old $1,007,844 $2,015,688 $3,023,532

Your human capital is likely a far bigger asset than any capital you have in investment markets or home equity.

Assumptions and myths quickly get outweighed by facts when people take the time to consider their exposure to risk of disability.

Most people have at least one of four faulty assumptions:

  1. I’m covered by Workers Compensation, Social Security Disability or my employer.
  2. Even if I have a disabling injury or illness, it won’t last long.
  3. I’m invincible. The odds of a disability are too low to insure against.
  4. Disability insurance is too expensive.

With those thoughts in mind, consider these startling facts:

  • According to the National Safety Council, Injury Facts report, in the home, a fatal injury occurs every 14 minutes and a disabling injury every four seconds. There is a death caused by a motor vehicle crash every 11 minutes; there is a disabling injury every 13 seconds.
  • It’s not accidents that lead to injury that create the most situations of disability. Disabilities due to illness represent 90% of all instances according to a 2002 JHA U.S. Group Disability Rate and Risk Management Study. The top three causes of long-term disability — heart disease, cancer, and musculoskeletal disease — are usually not work-related, and therefore not eligible for workers’ comp.
  • According to the U.S. Census Bureau, 50 million Americans are considered disabled. Every 30 seconds, someone files for bankruptcy due to the impact of a serious illness.
  • Things that used to lead to death now disable. Medical advances have kept more people from dying but in many cases, do not fully heal, therefore, as incidence of death goes down, incidence of disability goes up.
  • Approximately 60% of claims for Social Security Disability income are denied. The average monthly payment in cases that are approved is $1,004, barely above poverty line.
  • The Bureau of Labor Statistics determined that only 29% of all employed people have long-term disability coverage through their employer. Many employers provide short-term disability coverage but group policies for long-term instances are not well utilized.
  • Income from group long-term disability insurance is taxable. In reality, a standard 60%-of-income benefit, pays out much less than that after tax.
  • Typical disability insurance premiums cost roughly 2-3% of income.

Three ways to acquire adequate coverage

  1. Through your employer group plan, purchasing more on your own than is offered if needed.
  2. Through a professional organization. If your company does over long-term disability coverage, an association or professional group you belong to may.
  3. Buy it on your own. Individual disability insurance coverage is the most flexible and reliable if you qualify. You can supplement employer-based coverage with individual coverage. With individual coverage, you don’t have to worry about a job change eliminating your disability coverage. You can evaluate the best policy across multiple carriers to obtain a competitive rate.

For a worksheet to determine how much disability insurance is enough, or to inquire about a thorough analysis of your financial situation, please send an email to info@bhjadvisors.com

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